3x6%: Is It Possible for Turkey? (Growth, Inflation and ... - Odeabank

3x6%: Is It Possible for Turkey? (Growth, Inflation and Current account deficit/GDP) Economic Research and Strategy March 2013

3x6%: Is It Possible for Turkey?

03/18/2013

Global Commodities: Low Volatility amid Milder Risks  Commodity markets are exposed to both upside and downside risks: - Upside Risks: Global liquidity triggering the ongoing optimism regarding forward looking global growth expectations is the main driver. An improved outlook starting from the second half of this year moving into 2014 in US, China, Japan against growth and economic stability concerns in Eurozone peripheral countries are major drivers of commodity consumption in the year ahead. - Downside Risks: FED’s timing for withdrawing excess liquidity and fiscal balance concerns such as sequestration, weakness in Eurozone economic data after Italian elections and widening sovereign spreads for some of the Eurozone peripheral countries along with China’s recent attempt for cooling down the property market have been dragging commodity prices down with the global growth expectations getting milder and later than expected. Geopolitical risks stemming from Arab Spring, Israel-Iran tensions and upcoming Iran presidential election in June’13 are also worth to mention though less likely to occur in the year ahead when compared to 2011-2012.  Commodity price indices given in Graph 1 and oil volatility index given in Graph 2 indicate the most stable trends of last 5 years. Although it might be premature to comment on sustainability of low volatility, index values fluctuate within a narrow range with downward overall trends.  Renewed optimism stemming from reduction in geopolitical tail risks, expansionary monetary policies and fundamental data that reveals premature signs of a smooth recovery in US indicate less risks for commodity prices on both upside and downside in the absence of strong demand prospects and supply side shocks.  Our analysis in this note focuses on oil price outlook in 2013-2014 and aims to provide an assessment of its impact on Turkey’s macroeconomic conditions

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3x6%: Is It Possible for Turkey?

03/18/2013

Oil Price: Supply & Demand Conditions in 2013 



In the beginning of 2012, the modest demand recovery combined with the trade restrictions on Iran and other supply curtailments resulted in higher oil prices. However, no supply side shocks are expected in 2013 on contrary to 2011 (Libya) and 2012 (Iran) while year on year change of demand and supply are both in decreasing trend. Oil demand is expected to improve in 2013, however, global growth on the back of recent data from UK, France, China and emerging markets signal only a gradual recovery. World Industrial Production and GDP prone to converge around 2.8% and 3.5-4% respectively. Converging trends for consumption, production and world global growth accompanied with relatively narrow range of oil price fluctuation (+/-10%) YoY observed lately could be the prevailing trend in the year ahead.

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3x6%: Is It Possible for Turkey?

03/18/2013

Brent and WTI Oil Price Spread: Reflections of Demand Conditions 





Brent price reflects demand-supply conditions for a broader territory compared to WTI, including Middle East and Europe and subsequently other regions of the world. When demand is considered, growth in Eurozone is hindered by uncertainties around the continuity of fiscal austerity. Eurozone peripheral countries though recovered from the dip, still have a long way ahead for sustainable and stable growth. Slowing growth in EMEA emerging markets also signal weaker demand. In the absence of supply shocks and economies moving towards stable growth pattern with concerns around fiscal balances , demand increase will be limited hence upside risks for Brent oil price is limited while downside risks are higher due to expected stronger USD currency rate as well as potential weak demand. WTI price reflects demand-supply conditions for US and subsequently other regions of the world. US economy is expected to perform better than many Eurozone countries in 2013. US is likely to be the leader in terms of growth among advanced economies after a prolonged recession period. In H22013, fundamental data in US will probably confirm stronger US growth going forward. On supply side, this demand could be counterbalanced with US Strategic Petroleum Reserves (US SPR) along with shale gas substitution effect and also efficiency of new oil fields on current basins in the short run, i.e. Spraberry field. The outlook in the long run is vague as substitution effect of more shale gas coming into the market will increase as we get closer to 2015 and supply in US may be enough to counterbalance increased demand stemming from a potential stable growth pattern from 2014 to 2015. In this respect, WTI will be more exposed to upside demand pressures than Brent and the price gap between Brent and WTI may narrow throughout this year slightly.

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3x6%: Is It Possible for Turkey?

03/18/2013

Oil Price: Negative Correlation with USD Strength  US economy is expected to pick up gradually in H22013 and in 2014. USD trade weighted currency index against 6 major trade partners gets upside momentum already as USD appreciates globally (see graph 7). Brent crude oil price is inversely correlated to USD index, i.e. and it decreases as USD appreciates. As US economy steps in to an early recovery stage, USD will appreciate against major currencies given the uncertainties about Eurozone economic stability, (particularly Italy, Spain, Greece and Portugal), lower than expected growth prospects in UK and France accompanied with slower growths in EM.  As global economies move from recession to early recovery growth stages, excess liquidity in the market will be clawed back with monetary tightening and US will be the one of the leaders of this tightening. Therefore, US dollar strength will most probably continue against major currencies. USD will offer higher interest rates as the inflation becomes more pronounced with potential pick up in growth, monetary tightening and relative performance of the economy.  Oil prices in general are negatively correlated with USD strength however Brent oil prices have a stronger correlation with USD rates. The change of Brent oil prices for a unit change in USD rate is higher than that of WTI, therefore, gap between WTI and Brent oil prices will further narrow down due to exchange rate impact as well as demand-supply conditions discussed previously.  This downside impact will be counterbalanced by demand higher than the available supply conditions when prevails, which may probably put some upward pressure in the end of 2013 towards 2014.

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3x6%: Is It Possible for Turkey?

03/18/2013

Putting all together for our oil price expectations…  In line with the commodities in general upside and downside risks associated with oil price are more foreseeable and less severe compared to last 5 years which reflects itself as lower price volatility prevailing in the market. o Direction of the world economy is more certain and pointing to a gradual but steady recovery which is the main prospective uplift for oil prices. US seems to be the first developed market to recover and return to stable growth path and hence the first developed economy to stop expansionary monetary policies. Eurozone will be the laggard due to its peripheral members woes. Eurozone weakness limits the upside risks on oil prices as it is a drag on the global economic recovery o Tail risks are still valid but much less pronounced in our opinion compared to 2008-2010 (global crisis) 2011 (Arab Spring) and 2012 (Israel-Iran sanctions and heavier Iran sanctions)  Due to the differential of recovery pace between US and other developed nations the spread between WTI and Brent oil prices are bound to narrow  As the oil prices are negatively correlated with USD index we expect oil prices to remain under pressure in 2013 in the absence of significant demand and supply shocks as the recovery in the US will lead to a stronger USD against other developed market currencies.  Putting all together we expect: o

WTI Oil Price to range between $80-$100, (current spot $92, narrow range $80-$90)

o

Brent Oil Price may range between $80-$120, (current spot $108, narrow range $90-$100)

o

WTI-Brent spread to vary between $8-$12, (current spot $16)

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3x6%: Is It Possible for Turkey?

03/18/2013

Effects to Current Account Deficit… Current account deficit cut pace in 2012 driven by contraction in domestic demand, falling from US$ 75 billion in 2011 to US$ 46.9 billion in 2012. As a ratio of GDP, current account deficit eased from 9.7% to three-years-low of 5.9% during this period, while economic activity recorded a moderate growth of approximately 2.6%. Consequently, Turkish economy has achieved a soft-landing for the first time ever, however recession in Turkey’s main trade partner of European economy continues. In this respect, understanding how current account deficit declined significantly in 2012 become more important to estimate the future trend as well as risks regarding the deficit. After 2010, non-energy component started to improve thanks to sustaining financial stability. As we mentioned before in our 2013 Outlook Report, understanding the importance of the measures taken to ensure financial stability by the Government and BRSA and CBT in particular since late 2010 will be critical for the following period. In Turkish economy, the first unnamed program after Transition Program to a Strong Economy began to be applied from the end of 2010. Note that TL is still undervalued by 22% against euro-dollar equal weighted basket and more than 10% against emerging market currencies compared to late 2010, in light of the program. Thanks to a more competitive TL and rebalancing in economic activity, we expect a slight increase (0.5%) in non-energy current account deficit to GDP ratio in 2013, after 0.5% surplus in 2012.

In order to limit external imbalances, reducing energy imports dependence remains a crucial issue. Energy imports accounted for almost two thirds of the foreign trade deficit during the period after 2008. In other words, current account deficit to GDP ratio fell to 5.9% in 2012, of which price effect on energy imports as a ratio of GDP (compared to 2003 oil prices) was 5.0%, according to our calculations. Therefore, a possible decline in oil prices will pull total current account deficit down significantly. According to our regression analysis, every US$ 10 fall in oil prices will reflect 0.6% (or US$ 5 billion) decrease in current account deficit to GDP ratio, vice versa. Moreover, there is a meaningful negative correlation between oil prices and terms of trade (see Graph on the next page). Therefore, possible fall in oil prices may make higher contribution than envisaged not only in current account deficit but also in risk premiums. Just as, when Standard & Poor’s has downgraded Turkey’s rating outlook from positive to stable, it underlined concerns about external demand and worsening terms of trade. By the way, when energy prices make less contribution to current account deficit, protecting recent improvement in non-energy imports will become more important. Thus, the most important challenge in 2013 will be to make foreign demand as well as domestic demand provide positive contributions to GDP growth rate for the first time ever. On the other hand, we think the course of Turkish foreign policy –especially relations with neighbors such as Northern Iraq- may be a game changer through sustaining market diversification on energy imports as well as more competitive energy prices. 7

3x6%: Is It Possible for Turkey?

Current Account Deficit to GDP

12%

3% 2%

6%

0.70%

0% -0.76%

2007

2009

2011

2013F

-4% Source: TURKSTAT, Treasury and Odeabank Research

Source: TURKSTAT, Odeabank Research

5.01%

2.27%

Source: TURKSTAT, Odeabank Research

-0.92% Energy exports

Non-energy CA deficit

Energy imports based on 2003 prices

Price effect on energy imports

-0.50%

6% 5% 4% 3% 2% 1% 0% -1% -2%

Current Account Deficit to GDP Forecast in 2013 4.82% 2.54%

0.49% -0.95%

Price effect on energy imports

Current Account Deficit to GDP in 2012

Energy exports

2005

Non-energy CA deficit

2003

Non-energy CA deficit

0%

Energy imports based on 2003 prices

-1%

Energy exports

2%

6% 5% 4% 3% 2% 1% 0% -1% -2%

2.23%

1%

4%

-2%

3.71%

Current Account Deficit to GDP (2006-2012 Average)

Energy imports based on 2003 prices

8%

4%

Non-energy current account deficit Energy exports Price effect on energy imports Energy imports based on 2003 prices

Price effect on energy imports

10%

03/18/2013

Source: TURKSTAT, Odeabank Research

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3x6%: Is It Possible for Turkey?

03/18/2013

Effects to Inflation… In Turkey, effects of change in energy prices to inflation remain limited compared to effects to current account deficit. Pass-through of international oil prices to energy inflation in Turkey mainly depends on Government’s decision via price adjustment of Petroleum Pipeline Corporation (BOTAŞ). In this perspective, correlation between international oil prices in TL terms and energy inflation remains comparatively low. For example, when oil prices in TL terms jumped by 56% in 2011, energy prices increased only by 9.4%. Similarly, when oil prices rose slightly by 6.9% in 2012, energy inflation recorded a double digit increase at 13.9% due to hike in electricity and natural gas prices. We expect 10% increase in energy prices in 2013, under the assumption of only 1.3% increase in TL denominated oil prices. That

Brent vs Energy Inflation

60%

being said, energy prices rose only by 1% in the first quarter of the year, though we maintain our approximately 7% price hike of both in electricity and natural gas throughout 2013. On the other hand, not only oil prices but also other commodity prices recorded a significant increase by the end of 2012 compared to pre-crisis level. Therefore, current oil price levels will pose downside risk on global inflation due to limited year-on-year change (see Graph). Moreover, excise tax on gasoline prices in Turkey was significantly above European countries and double of OECD average. Higher tax rates may be a downside risk on inflation for mid-to-long-term. To sum up, if oil prices remain at or lower than current level, energy inflation will pull headline inflation down moderately, especially under no hike in natural gas prices as well as electricity prices assumptions.

Brent Oil

50%

115

40%

105

30%

95

20%

30%

85

10% 0% -10% 0% 2006

2007

2008

2009

2010

2011

2012 2013F

75 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013F

-20%

55

-30%

45

-40% -30% Source: Bloomberg

Energy Inflation

Brent (TL)

-50%

65

YoY (lhs)

Price level (rhs)

35

Source: Bloomberg

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3x6%: Is It Possible for Turkey?

03/18/2013

60%

2.8%

3%

40%

3% 2%

Brent vs Electricty&Natural Gas Inflation

80%

Contribution of Energy Prices to Consumer Inflation

1.9%

1.7%

1.6% 1.7%

2%

1.4%

1.1%

20%

1.1%

1.0%

1%

2006

0.4%

1%

0% 2007

2008

2009

2010

2011

2012

-20%

0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013F

-40%

Electricity prices

Brent (TL)

Natural gas prices

Source: TURKSTAT, Bloomberg, Odeabank Research

Source: TURKSTAT and Odeabank Research

Policy Rates in Emerging Countries and Turkey

Weight of Energy Prices Within Consumer Inflation

12.00%

14%

10.00% 13.2%

13.2%

Turkey

12.7%

13%

12.2% 12%

11.6%

11%

11.6% 11.5%

12.2%12.4% 11.5%

Emerging countries average

8.00% 6.00%

10.4%

4.00%

10% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Eurostat

Source: Bloomberg and Odeabank Research

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3x6%: Is It Possible for Turkey?

03/18/2013

Effects to Monetary Policy and Risk Premiums In conjecture with moderate or lower commodity prices, especially oil prices, risk premiums regarding Turkish economy will further improve through improvement in external balances and expectations channel. That said, 5-year CDS spread hit its lowest level at 113.9 in early-2013 as a preliminary result of unnamed macroeconomic program, as we mentioned before. Similarly, correlation between oil prices and Turkish CDS has been broken since late-2010. There was a huge negative correlation at -70% during the last decade, but after 2010 correlation fell only to -5%. In this perspective, we think that after 2010, sustaining financial stability rather than uncertainties on current account deficit driven by oil prices become more important as a determinant of CDS.

900 800 700 600 500 400 300 200 100 0

Correlation: -70%

Source: Bloomberg, Odeabank Research

Brent Oil Prices vs Terms of Trade

Brent Oil (rhs)

Cor.: -5%

0

140

20

120

Brent

40

100

Terms of trade

60

80

80 100 120

60

40

140

20

160

0

0.85 0.87 0.89 0.91 0.93 0.95 0.97 0.99 1.01 1.03 1.05

Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12

Turkey 5-Year CDS

Besides there is a meaningful negative correlation between oil prices and terms of trade, as we mentioned above. As a risk factor, terms of trade will improve when oil prices loose momentum. This is important especially for credit rating agencies to evaluate sovereign ratings. To sum up, as risk premiums remain under pressure, CBT’s current policy stance will continue for a longer time than envisaged. Also there is more room for further cut on interest rate corridor as well as in policy rate if risk premium goes down and policy rate cuts in emerging countries continue.

Source: TURKSTAT, Bloomberg, Odeabank Research

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3x6%: Is It Possible for Turkey?

03/18/2013

To sum up…  Consequently, we think recent developments in commodity prices, especially in oil prices, are pointing to downside risks somewhat. As discussed commodity analysis section, we think there is an evident risk on Brent oil prices to fall around US$ 10-15 during the rest of the year on the back of moderate demand-supply conditions, USD strength and low volatility.

 Trend and developments in oil prices in the coming period are crucial for current account deficit as well as risk premiums in Turkey.  According to our sensitivity analysis, if average oil prices decline to US$ 100 per barrel in 2013, we should revise our current account deficit to GDP ratio forecast significantly from 6.9% to 6.3%, and our inflation forecast may revise slightly from 6.3% to 6.2%.  In this conjuncture, rating agencies would consider upgrading Turkey’s rating to second investment grade.  However there is insignificant relationship between oil prices and growth, lower risk premiums may pose CBT’s policy stance for a longer time than expected thanks to better terms of trade and deceleration in current account deficit. Accordingly, 2013 GDP growth rate may converge to 6% as well.  Possible scenarios for the change of the current account and inflation with respect to different oil prices are given below:

-15

-10

-5

Base

+5

+10

+15

Brent oil price assumption (US$)

95

100

105

110

115

120

125

Current account deficit/GDP

6.0%

6.3%

6.6%

6.9%

7.2%

7.5%

7.8%

Inflation

6.1%

6.2%

6.3%

6.3%

6.4%

6.5%

6.5%

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3x6%: Is It Possible for Turkey?

03/18/2013

Odeabank Economic Research and Strategy Maslak Mahallesi Ahi Evran Caddesi No. 11 Olive Plaza Kat 9 34398 Şişli /İstanbul Phone: +90 212 304 87 42 Fax: 0212 304 84 45

Serkan Özcan, Assistant General Manager

[email protected]

Ali Kırali, Strategic Planning Director

[email protected]

Erkan Dernek, Strategic Planning Group Manager

[email protected]

İnanç A. Sözer, Economic Research Manager

[email protected]

Ferhat Yükseltürk, Strategic Planning Manager

[email protected]

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